Irrevocable Life Insurance Trust
(TX)

Summary

This template is an irrevocable life insurance trust and may be used in Texas as part of a coordinated estate and gift tax planning strategy for a high net worth person to remove a large asset from their estate for federal tax purposes. This template includes practical guidance, drafting notes, alternate clauses, and optional clauses. During the settlor's lifetime, the beneficiaries of the trust have "Crummey" powers to withdraw gifts made to the trust. These withdrawal rights are designed to qualify any gifts made to the trust (i.e., funds to pay premiums on the insurance policies) for the annual gift tax exclusion. See I.R.C. § 2503(b) and Crummey v. Comm'r., 397 F.2d 82 (9th Cir. 1968).Irrevocable Life Insurance Trusts (ILITs) involve tax planning and require strict compliance for the settlor to obtain the favorable tax treatment intended. There are several potential pitfalls unique to the settlor, the trustee, and the beneficiaries which are addressed in drafting notes throughout this template. One of the unique requirements of an ILIT is that the settlor may not serve as trustee, so as part of the initial planning it is important to identify a trustee with suitable education, experience, and training to avoid simple mistakes. If the trustee becomes overwhelmed with the complexity of the duties pursuant to the ILIT, your client may appoint a trust protector. The trust protector is typically a lawyer or CPA who can assist without disrupting the planning intentions set into motion by the settlor. You should be aware that many people are excluded from being named as a trust protector. There are two common scenarios for a high net worth settlor considering an ILIT: (1) they already have the life insurance policy in place and they will transfer that into the ILIT, or (2) they will transfer the money into the trust to then obtain the life insurance policy. Where the policy already exists, the "three-year rule" is invoked, and the settlor must survive three years for the policy to be excluded from their estate. See I.R.C. § 2035(a). Where the cash is transferred into the trust, the rule is not at issue. This template may be used for an unmarried person to benefit their children, or for a married individual to benefit his or her spouse and children by utilizing the optional and alternate clauses. In the event insurance trusts for both spouses are to be established, care must be taken to avoid the reciprocal trust doctrine. See U.S. v. Grace Estate, 395 U.S. 316 (1969); but see Tobin v. Commissioner, 183 F.2d 919 (5th Cir. 1950). For a full listing of key content related to estate plans for married or partnered people in Texas, see Estate Plan for Individual with Spouse or Partner Resource Kit (TX). For an in-depth discussion of trusts, see the practice notes Characteristics and Uses of Trusts (TX) and Requirements and Restrictions on Trust Purposes and Administration (TX). For an in-depth discussion of the taxation of life insurance see the practice notes Life Insurance and Estate Taxation and Life Insurance and Tax Exposure Management.